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Updated on Thursday, October 10, 2019
On Sept. 15, 2008, investment bank Lehman Brothers declared bankruptcy and set off the worst financial crisis the world has seen since the Great Depression. Stock markets around the world cratered, millions of Americans lost their homes and U.S. unemployment rose as high as 10%.
In response to the crisis — sometimes called the Great Recession — Congress passed the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010. What has this bill done for regular consumers? This series covers the history and key provisions of Dodd-Frank, including how it impacts your everyday finances.
How does the Dodd-Frank Act regulate banks?
One of the main causes of the financial crisis was that banks made too many risky investments, especially in subprime mortgage loans. In the years leading up to 2008, large banks owed so much money to each other that if one went bankrupt, it would spread and cause other parts of the financial system to fail. These banks were in a situation where they were “too big to fail.”
The Dodd-Frank Act set up new regulations to prevent banks from getting to the point where they became too big to fail. First, the bill created the Financial Stability Oversight Council (FSOC) to monitor whether banks were taking on too much debt and putting themselves in a risky position.
If the FSOC determines that a bank is heading into dangerous territory, the council could require them to increase their reserve requirements, meaning the bank has to scale back its lending and hold on to more cash so they are less likely to go bankrupt.
Finally, Dodd-Frank required that every bank come up with a plan for a methodical shutdown should they become insolvent and find themselves unable to pay off their debts. That would help keep the problem from spreading to other financial institutions.
How does the Dodd-Frank Act help consumers?
The main goal of the Dodd-Frank act was to stabilize the banking sector so that consumers would not have to go through the pain and suffering of another financial crisis. Beyond this key mission, Dodd-Frank also set up additional protections for mortgage lending.
The financial crisis was partly caused by a subprime housing bubble. People took out mortgages they couldn’t afford, which included confusing costs like adjustable interest rates that could cause the monthly loan payment to go up.
According to David Reiling, CEO of Sunrise Banks, “Dodd-Frank mandated new mortgage loan disclosures that were designed to ensure costs were clear upfront and throughout the origination process, and also required creditors to verify income and debts to ensure a consumer could repay the loan.” As a result, shopping for a mortgage is safer and easier.
Finally, Dodd-Frank created a new regulatory agency specifically to help with consumer financial issues: the Consumer Financial Protection Bureau.
The Dodd-Frank Act created the CFPB
The mission of the CFPB is to protect American consumers in the market for financial products and services while educating them to make better decisions. They oversee consumer loans, credit and debit cards, credit card reporting agencies and payday lenders.
The CFPB does this in a few different ways. First, they help consumers research their different options, both with tools on their website and by requiring lenders to make it easier for people to compare their products. For example, mortgage lenders must give you a new disclosure explaining their fees before you sign up.
Second, the CFPB educates consumers by providing free resources on financial planning, retirement and loans. Finally, consumers can file complaints with the CFPB and they will fine companies that engage in bad practices.
To date, the CFPB has helped over 31 million consumers and returned $12.4 billion to consumers that was previously lost to companies that broke the law.
How does the Durbin Amendment impact banks?
During the negotiations for the Dodd-Frank bill, Sen. Dick Durbin (D-Ill.) sponsored an amendment to add a new regulation to the law. The Durbin Amendment set a limit to how much banks can charge for debit card transaction swipe fees.
Before the Durbin Amendment, banks were charging on average roughly 40 cents per debit card transaction. After this rule went into place, the Federal Reserve set a limit where banks could charge no more than 21 cents per transaction.
“The expectation was that the additional cost savings by the merchants would be passed on to consumers,” said Reiling. If businesses were paying less in transaction fees, they could lower their prices for American shoppers.
Need a new debit card to take advantage of the Durbin rule? These high yield checking accounts currently pay the highest interest rates.
How does the Dodd-Frank Act regulate financial markets?
Banks were far from the only cause of the financial crisis, which is why Dodd-Frank also created new rules for other parts of the market. First, the bill created the Office of Credit Rating at the SEC to oversee credit rating agencies like Standard & Poor’s and Moody’s.
These agencies review how likely creditor is to pay off a debt based on their financial situation. A company, government or investment with a AAA rating is supposed to be safer than one with a C rating. The problem was that agencies were too loose with their ratings before the financial crisis.
Brandon Renfro, Assistant Professor of Finance at East Texas Baptist University noted “A key issue in the mortgage crisis was that high credit ratings were given to derivatives of repackaged subprime loans. The goal of the new Office of Credit Rating is to reduce conflicts of interest and ensure that ratings are accurate reflections of risk.”
Dodd-Frank also launched the Volcker rule, which prohibits banks from participating in higher-risk activities like hedge funds, private equity funds and other proprietary trading. The bill created new regulations for high-risk investments called derivatives, which led to unexpectedly large losses for investors. Finally, Dodd-Frank created the Federal Insurance Office to oversee insurance companies.
The Dodd-Frank Act today
In response to the devastating losses of the Great Recession, the Obama administration used Dodd-Frank to revamp the rules for our financial markets. While the rules have some clear benefits for consumers, Dodd-Frank still has its share of critics who say it went too far: that it limits economic growth and restricts the ability of banks to lend.
This is why President Trump and the Republican party have taken steps to roll back parts of the law while still keeping the main framework in place. To see how the rules have changed, including how they helped increase credit union CD rates, check out the next part of our series.